A benign quarter of weather-related catastrophe events as well as strong favorable reserve development provided a surge in first-quarter earnings at Arch Capital Group. Both primary and reinsurance lines reported favorable reserve development, but the reinsurance segment provided the bulk of it, reducing the combined ratio by 16 points to 79%. Favorable reserve development also helped the primary insurance combined ratio dip below 100%, resulting in positive underwriting income, which the segment has had difficulty achieving over the past few years.

Net earned premiums increased 11% in the quarter compared to last year, mostly from a 29% increase in reinsurance premiums that included new mortgage insurance business that began in the second quarter of last year. After-tax operating income return on equity was 13% in the quarter while net income return on equity soared to an annualized 20%. While Arch Capital’s first-quarter results were very strong and exceeded our expectations, we will stick with our fair value estimate of the stock, which is based on long-term results.

Catastrophe events that weigh on earnings are far more common later in the year, and we would expect that–even if claims from catastrophes remained low for an extended period of time–the sizable excess capital in the reinsurance industry would have a negative effect on premium growth. While we think Arch Capital is one of the better reinsurers, we do not think any participant in the industry has an economic moat.

Arch Capital will hold its quarterly earnings conference tomorrow morning and we will provide an update if additional relevant information is disclosed.